A sham contract is an arrangement where an employer deliberately misclassifies a worker as an independent contractor when, in reality, they are functioning as an employee. The objective behind such a contract is generally to avoid paying employment entitlements, such as minimum wage, sick leave, provident fund, and other statutory benefits, and to evade compliance with employment laws.

Key Characteristics of Sham Contracts

• The worker is labeled as a contractor or made to obtain a tax or business registration number (like an ABN), but all aspects of their work—such as control over tasks, fixed hours, and lack of ability to subcontract—point to an actual employment relationship.

• Sham contracts often involve an employer dictating the manner, timing, and place of work, providing essential tools and equipment, and limiting the worker’s autonomy—all hallmarks of true employment rather than contract/freelance arrangements.

• These contracts are sometimes set up to shift tax and compliance responsibilities to the worker and to deny them their lawful benefits as employees.

Legal Perspective and Implications

• Sham contracting is generally illegal. Courts look beyond the written contract to the actual working relationship, using various legal tests (such as the control test, organization test, and multifactor test) to determine the true nature of employment.

• If a sham contract is established, the worker may be reclassified as an employee and become entitled to all employee rights and back pay.

• In India, sham contracts may arise when contract labor is supplied through a so-called contractor who is a mere “namesake” and all real control is with the principal employer. Courts may "lift the veil" to reveal the true employer-employee relationship and mandate regularization or provide employee benefits.

Why Sham Contracts Matter

• They undermine workers’ rights, social security, and fair employment standards.

• Businesses using sham contracts face serious legal penalties, including fines, payment of back wages, damages, and loss of reputation.

In summary:
A sham contract is a deceptive practice where an employer disguises an employment relationship as a contract for services, mainly to avoid legal responsibilities. Both in India and internationally, such contracts are prohibited and, if detected, are set aside by courts to ensure workers receive their legitimate rights and protections.